Back in August 2005, at the tail end of the housing bubble (but when many VC readers were still berating me for saying [or, more precisely, siding with the many "doomsayers" who were saying] there was a housing bubble), I pointed out one future source of trouble for the housing and mortgage markets:

Just read that 61% of all new California mortgages this year are interest only, no money down. This is especially important because California (like a few other states, but, unlike, say, D.C. area jurisdictions where about 50% of the new mortgages are interest only) has a law requiring that all mortgages be "non-recourse," i.e., if a mortgagee defaults on his loan, the bank cannot attach any of the mortgagee's other assets, but can only foreclose on the house. If prices drop significantly in the next couple of years, as they likely will (given that only 17% of Californians can now afford the median house), thousands of people are going to walk away from their loans and let the bank foreclose, with no bankruptcy consequences. Sure, it will ruin their credit record, but how much is a good credit record worth? Probably not $120,000 (the negative equity on a $600K loan--median single family home price in California--if prices decline a modest* 20%). Anyway, many of the loans are adjustable with "teaser" rates used to qualify the buyers, who understand that in two years they will have to refinance or sell, because they won't be able to afford the new payments. They are counting on interest rates being lower, or on being able to "flip" the house for more money, and using the proceeds to get "back in the game."

A Conspiracy reader who was an executive at Indymac emailed me that the banks were aware of this possible dynamic, but were confident that home buyers would protect their credit rating at all costs, and wouldn't default on their mortgage unless they really couldn't pay their mortgage, regardless of how far "underwater" they were. This is when I first concluded that the banking industry was out of its collective mind. (And of course, as it turns out, even in "recourse" states, "jingle mail" is an ever-growing problem, and banks rarely try to go after any assets that the borrowers may have).

UPDATE: Part of the problem, from what I can tell, is that the mortgage industry was relying on worst-case scenarios based on default rates from past housing busts, such the early 90s in California, and the 80s in Texas. Yet those were totally different circumstances, not least that those default rates were based on borrowers who generally put 20% down, and thus would think really hard before defaulting, credit rating aside.

Ok, so some people were dumb enough to take out loans they couldn't afford to pay back and some people were dumb enough to lend money to people who clearly might not be able to pay back. What does this have to do with me or anybody else?

Well, no need to "think" anymore, because my email is back up, and I can confirm it was someone from IndyMac. But I'm not feeling very prophetic. It was bleeding obvious in Spring/Summer 2005 that prices had way overshot and had to regress to the mean, and that people who found themselves 100K or more underwater and had no money down were going to walk. Which meant that it was obvious that lenders were taking at incredibly stupid risk in giving people no money down loans. There were plenty of other people saying so, as the archives at thehousingbubbleblog.com will attest. But, on the other hand, there were such compelling arguments on the other side, such as, "they're not making any more land," "immigrants will buy all the new houses," "prices have never gone down on a national basis in any year since the Depression," and, especially, "everyone wants to live in [San Diego, South Florida, D.C., Boston, L.A., FILL IN THE BLANK]".

It was changed because my mail archives were down, and now are up, so I was able to confirm. Given that the post was only up briefly before I made the change, I don't see any reason to clutter it with an "update."

Your posts always cop the same know-it-all attitude while taking great pains to point out the foolishly optimistic positions some people staked out. The comment you reference in this thread (out of at least a dozen others) is the only time I've seen you acknowledge that you were not alone in the universe in observing that residential real estate prices were a bubble.

If you'd made a bunch of money, I am confident you'd have also made at least a half a dozen posts about it. cf. the endless stream of posts about your own home-buying experience. Care to correct me?

I've linked to the housingbubbleblog.com at least a half dozen times (e.g.), linked a prediction of pain in the housing market by Heebner, and that's just off the top of my head. If you're going to be obnoxious, at least get your facts straight. And, moreover, don't be a coward and use your real name, not an alias. When you reveal your identity, I'll continue this conversation.

You say at the end that, even in states with recourse lending, "banks rarely try to go [after] any assets that the borrowers may have." That's quite true. In fact, the Wall Street Journal recently had a very interesting story reporting that banks are going so far as to offer cash payments to defaulting borrowers to get out of their houses without trashing them or opposing foreclosure. Has the world turned upside down?

Finally, if you were so clear-eyed, why didn't you make a bunch of money on the debacle (e.g., by shorting the stock of companies with known extensive exposure to these mortgages)?

I take it you aren't a very active trader. There's a difference between knowing a situation is untenable and knowing how to time that situation to make money off of it. Here are a couple clues to tell you a sector is due for a heavy correction:

"This time it's different!"
"x never goes down!"
"Learn how to get rich with no money down!"
A cable channel has a show dedicated to making quick money by "working the market."

I'm still getting clients (2 this week) who say they are ready to walk away from 6 or 7 houses that are $50k underwater because they don't have tenants and their savings is gone from making the payments.

From here it looks like it's going to get worse before it gets better.

Maybe there is just too much boomer pension money looking for someplace to invest at a better than 2% rate. I think 2% has been closer to the historic norm. But after seeing 8% and 10% and 12% yields in the 70s and 80s people thought they could retire on little money. Now it turns out maybe almost no one can afford to retire (in style).

Don't listen to the naysayers. It's always difficult to argue that there's an asset bubble, because it amounts to arguing that the market isn't, in fact, always efficient -- the constant derision and condescension from free market fundamentalists (who usually have little formal training in economics) is a surprisingly strong deterrent. I remember what the housing bubble debate was like ("vitriolic" I think is the best word for it), and the people who saw the housing bubble coming deserve a few rounds of "I told you so." Too bad all the housing bubble deniers have mysteriously disappeared!

I'm not sure who started the anonymous commenter == coward meme, but I love it. I'd be interested to know if you think your formerly anonymous co-blogger was being cowardly when he posted as "Juan Non-Volokh." Too bad my own cowardice will prevent me from getting a response!

As for my being obnoxious about this (and perhaps generally), guilty as charged. Though it's certainly a case of the pot calling the kettle black.

In any event, you're right, I looked back through some of your other posts and several of them did link to outsider bubble comments. Other posts, I maintain, reflected the same haughty attitude that is in this post.

I'll finish by noting that you have no claim to being especially prescient for predictions made after this (quoting on 7/1/2005 the CEO of Toll Brothers predicting a large drop in housing prices).

"I take it you aren't a very active trader. There's a difference between knowing a situation is untenable and knowing how to time that situation to make money off of it."

I'm plenty familiar, and this is precisely my point. Look, Greenspan made his (in)famous "irrational exuberance" comments about 4 years before the stock market bubble burst. But ya know what? A lot of centimillionaires and billionaires were minted from 1997 to 2001 (and not all of them just on paper). They're the ones who get to gloat, not the people who sat smugly on the sidelines reminding everyone that water is wet and all bubbles eventually burst or deflate.

Now if DB did get the timing details right on the burst, then kudos to him.

I promise promise promise this'll be my last post on the issue, but I just want to note that Jan 2008 put would've been much more lucrative than the Jan 2007 puts he was flogging. (I'm assuming they were priced similarly at the time of his recommendation. The usual stock quote sites don't seem to have historical put prices.)

It's only an aside, but BBC is indicating IndyMac was forced to shut the doors because of a good old-fashioned Bailey Savings and Loan run on the bank, induced by Chuck Schumer seeing a convenient microphone to be had for raising a small fuss.

David, whether or not you made money on the bubble (and I didn't), we can both take solace in the fact that we're not 'stunned'.

Mike, I'll predict that the Dow will never hit 15,000. In fact, I'll predict that it monotonically decreases until it gets to 6,000, at which point China decides we're so crippled it can weather a first strike. Seeing as how doomsday prophets are always right, I guess we're pretty screwed now, huh?

IndyMac was placed in receivership because of a liquidity crisis, not because of insolvency. Since Schumer's letter became public, depositors had withdrawn $1.3 billion at a rate of approximately $100 million per day. The Federal Reserve and the Federal Home Loan Bank System cut off IndyMac's borrowing window.

If Indy Mac had been able to pursue merger/sale options on its own, there might have been something salvageable. Despite its problems, it still had capital. But, receivership equals fire sale, and FDIC is notorious for negotiating poorly in these situations. As it is, some commentators say, this may cost the FDIC insurance fund upwards of $12-13 billion (out of total reserves in the range of $52 billion). That would bring the FDIC reserve ratio (already low at 1.19%) down below 1%.

Hoqw does it affect you? It is unlikely that there would be a taxpayer-funded bailout of the insurance fund, but assessments on bank deposits will go up tremendously -- that will affect interest rates and loan availability. In the end, the money comes out of the pockets of the depositors and borrowers, and, indirectly, consumers.

Thanks, Chuck. Of course, Chuck blames the regulators -- there was no run, he says, and if there was, it wasn't his fault. But it was -- he took a bad, possibly salvageable, situation and made it worse.

In addition, if you take a look at Yahoo Finance for IndyMac, you will see that (as of the last filing date for Schedules 13G) there are quite a number of institutional investors that held IndyMac stock. It was already close to worthless, but now it has probably gone to zero. The losses will affect 401(k)'s and pension fund values.

This is a walk in the park compared to the impending bailouts of Fannie Mae and Freddie Mac. They will be bailed out either directly or via monetary tricks such as inflating the currency and keeping interest rates artificially low.

IndyMac is not the victim of a miscalculation of borrower behavior. That's only one half of the problem. IndyMac, and every other foolish lender, had an incentive to make bad loans (and, therefore, big bucks) because they could bundle the questionable loans and leverage the bundles as AAA securities.
Thus, just as with the savings and loan scandal in the early 90s, the problem is separating reward and risk. If you are lending your own money, you'll be sure the borrower has the ability to met the terms and conditions he agreed to. When you get paid to pass the risk on to some big bank/institution, what do you care about a questionable loan?
The potential damage now comes from efforts to bail out the parties, the flawed borrowers, the greedy lenders and the dumb bundlers, all of whom ignored the risks. Lots of folks saw this coming and LOTS of people made money on that vision, they bought puts and sold short on the house builders (too much existing inventory), banks and anyone holding the bundled securities. Simply look at Citigroup (C) to see what could have been made by buying puts in the first quarter.

Alan Greenspan was an idiot as are ANY of the economists who do not take the Austrian School of economics seriously on this. The Austrians have the only model of the economy that actually makes sense. They inflated the MONEY supply to counteract the nature PRICE deflation that occurred due to the opening of world markets. Price deflation due to increased goods production is a good thing but monetary inflation is always a bad thing.

This falsified the monetary signals being sent within the economy and resulted in malinvestment. People thought they were doing better than they actually were and were overinvesting in long term projects like housing and internet companies that would not pay out in the end.

All the signals of monetary inflation predicted by the Austrians to occur are with us. Low savings, overextended borrowing, commodity price inflation, trade imbalance. The Austrian theory not only tells you why this happens but they also have a clear mechanism by which it happens. Unlike the theories that inspired the creation of the FED it doesn't work by "magic".

The bad thing is that the hurt is not over yet. The damage has been done and is being hidden by low interest rates. Problem is that that damage is going to have to be exposed and dealt with at some point. The correct thing for the Fed to do now is to neither increase nor decrease the money supply. Unfortunately they have not only interferred in the money supply but in the mechanics of the fractional reserve system.

They have allowed us to become overleveraged. This means that instead of having to deal with an economy that is like a cherry resting inside the bottom of a upright bowl, the natural outcome of free markets, we are dealing with an economy that looks more like a cherry resting on the top of an inverted bowl. On one side is deflation and the other inflation.

The government itself has no assets so it's "guarentees" are pretty much worthless in and of themselves. They can only "fix things" by distributing the errors they have collectivized. Yes, screwing with the money supply causes us humans to all make bad economic decisions in synchrony. But if most everyone is now in error about their economic condition then even taxation isn't going to pull economic prosperity out of the hat.

If the Fed "does nothing" that will be deflationary and the people who have been getting rich quick off of asset inflation will be harmed along with those who lent them the money if they go bankrupt. Problem is that's pretty much everyone. Plus the government owes lots of money to foreign entities so they will, in fact, try to avoid this outcome. The cherry will not quickly this way but it will be pushed this way as banks and other institutions that are leveraged collapse.

The FED can just let them collapse for this reason. The problem is that any "fixing" that is done will be highly inflationary. The problem is that these things are leveraged. So to pay the person who invested or lent to a bank 100% of his money back one must increase the currency by the leveraged amount.

If you lent $100,000 to your bank by depositing it and then lent out $90,000 to others to invest in housing that is now worth only $45,000 then then in order to inject enough "liquidity" into the system to pay you back they are going to have to cough up $45,000 and sell off the asset to someone. That's if you want your cash back and you have it in a short term deposit account.

In other institutions like Freddy and Fannie the leverage is far worse. There is leverage around fifty to one.

Trying to correct all this is highly inflationary. You think the commodity price rise has been large so far, well wait till the consumer prices start to kick in. Yes, that is another prediction of Austrian economics. Commodity prices go up first then consumer. I could explain why all this happens but frankly I don't have the time.

Sorry about the "it's 'guarentees'" and other typos. My brain knows how to read but I my hands type contrary to how I speak, or read. Should be "its guarantees". I guess I should proof read but I want to get outside and garden.

Worked briefly with Resolution Trust Corp. in 1990, which had taken over mismanagement of every single S&L in Arizona. No, not a typo. I saw some files on loans that were insane. E.g, secured only by a CD from the lender which was purchased from fund lent. Empty desert land bought at high prices. Etc., etc.

Only sense I could make of it was that the lenders were just convinced the realty bubble was never going to pop, so that the most foolish loan would still pan out.

If this bubble bursting is a precursor for much much more pain over the years ahead, I think we really have to have a government in place that will be more hands on then in the recent past in actually providing "adult supervision" of those elites in the financial, food, and energy sectors. Those elites appear to have operative visions that are so narrow and shortterm that they manage to do all these horrendous dumb things.

Glass-Steagall was passed because of the 1929 crash. 25 years ago I remember bankers like Citibank pushing and pushing and pushing to lift all those Depression era restrictions on them saying "this time is different".

I hope this works out, but I suspect that far too many people have been asleep at the switch. Just hope the most disadvantaged do not bear the brunt of the pain for once.

Mike, I'll predict that the Dow will never hit 15,000. In fact, I'll predict that it monotonically decreases until it gets to 6,000, at which point China decides we're so crippled it can weather a first strike. Seeing as how doomsday prophets are always right, I guess we're pretty screwed now, huh?

Too specific for a doomsday prophecy. You must be vague. For example, Bernstein had long said that we were in a housing bubble. He never got anymore specific, e.g., by saying when the bubble would burst. Well, as prices tend to rise and fall, someone saying we're in a bubble will of course eventually be right.

But so what? What does that prove? It certainly isn't evidence of special insight. It's just the type of tricks psychics use every day. It's no different from the oracles telling the Athenians to put their faith in their "wooden walls."

If you can't get the distinction, I'd encourage you to pick up a copy of a book on cold reading from James Randi's site. Here's a primer on how to be vague enough that you'll always and eventually be "right."

If you want to say, "One day the U.S. will not be a world superpower," then of course your prediction will come true.

The question is: Does that tell us anything about your predictive abilities?

If you can't be specific, then your "prediction" is per se a guess at best, and a ruse at worst.

Brian Macker said: "Trying to correct all this is highly inflationary."

That's correct, and our high interest rates (relative to other nations) have devalued our currency. We're now at $1 = 0.50 Pounds and 0.63 Euros. This is not a good time for vacationing in a foreign land. Our devalued currency also is responsible for most of the recent oil cost rises. If our currency was as strong as it was 3 years ago, those $130 per barrel oil prices would be around $95 per barrel.

One of the downsides of economic interdependencies is that a relatively small group of people acting like greedy sheep (Lender A is giving out no money down, 2% adjustable rate mortgages and making money, so we should do the same!) can disrupt the entire national economy. And some people thought Enron was a big deal. I'll take 50 Enrons over the mess we have today. Any bets that all the irresponsible executives at the lending companies and remortgage companies either keep their jobs or walk away with bonuses or golden parachutes?

Professor Bernstein was right about the bubble. Us old unreconstructed New Dealers were on this way before that. Big blocks of money attract crooks. An ideology that says locks are bad is just looking for trouble.

Glass-Steagall was repealed during the first Clinton administration.

I bet Phil Gramm feels like an idiot. He always was one, but he picked a poor time to speak up for the robber barons, didn't he?

Actually, in March 2005, I wrote, "I'll be bold enough to predict that we are at or near (within a few months) of a market top now." But I admit that in retrospect this was something of a lucky guess, and it's that much harder to guess how the markets will react to such news, see, e.g., the inexplicable rally in housing stocks in Fall 2006, and, to a lesser extent, earlier this year.

[Editor: Comments deleted for multiple violations of commenting policy, such as one starting with "Get over yourself, Professor Bernstein." I'll give the commentor some leeway if he chooses to identify himself.]

And more to the point, the point of this post was not, pace Instapundit, "I told you so," but was really setting up the Indymac correspondence, which I think makes it obvious why it, and other financial institutions, were in such trouble: the risk profile they were relying on was based on fantasies like the idea that people treat their credit ratings as invaluable.

<i>"Any bets that all the irresponsible executives at the lending companies and remortgage companies either keep their jobs or walk away with bonuses or golden parachutes?"</i>

Are you trying to claim that this is a "big business" issue? If so you are sadly mistaken. This is all about corruption of free market processes, just like the Enron example. ... and yes we need judicial processes to maintain a free market, so I'm not advocating "anything goes".

Laissez Faire isn't "anything goes". It's "leave us alone" and it's quite clear that the government hasn't "left things alone" here. Forcing interests rates down to around 1% (not letting the market seek its price) is not leaving things alone.

This is the same kind of governemental meddling that happened pre-Great Depression, and pre-70's inflation. In addition the government has come up with new way to create bad incentives in the economy.

IndyMac was placed in receivership because of a liquidity crisis, not because of insolvency. Since Schumer's letter became public, depositors had withdrawn $1.3 billion at a rate of approximately $100 million per day. The Federal Reserve and the Federal Home Loan Bank System cut off IndyMac's borrowing window.

I haven't followed the IndyMac situation closely, but I don't understand this comment. If the bank were solvent but illiquid why cut off the borrowing?

Isn't it more likely that it was insolvent but there was hope of recovery in asset values?

Not only did you delete my comment where I said you ought to "get over yourself," you also deleted
1) your OWN comment in which you claimed to have predicted in April 2005 that the end of the bubble was coming within months because of "end of bubble" evidence like condoflip.com. (Clearly referring to this post.)
2) my response to that comment (in which I made not a single personal remark), pointing out that, not only was that assessment made in June 2005, but that it was made one week after The Economist said, "PERHAPS the best evidence that America's house prices have reached dangerous levels is the fact that house-buying mania has been plastered on the front of virtually every American newspaper and magazine over the past month. Such bubble-talk hardly comes as a surprise to our readers. We have been warning for some time that the price of housing was rising at an alarming rate all around the globe, including in America. Now that others have noticed as well, the day of reckoning is closer at hand. It is not going to be pretty."

I don't think that kind of editing of the discussion is fair or reasonable.

So your complaint is that though DB was amazingly accurate in forecasting the end of the bubble, lucky guess or not, he was off by a couple of months 3.5 years later in recounting an example of why he came to that conclusion? Pretty petty.

My original complaint was with the self-congratulatory tone of Professor Bernstein's original post. He has since edited it to make it more fair.

Everything else I've said has been in response to follow-ups from him and other commenters. Yes, he, along with many many others could see that the end was nigh in the spring and summer of 2005. As he acknowledged in his post above, that and a quarter will get you a bag of chips.

My last quibble is that he took the opportunity of subsequent bad behavior on my part to paper over his own misrepresentations about his predictions. (Indeed, I made a mistake above, he deleted one of his own comments and edited another.) I have no doubt that he made his condoflip.com comment in good faith, but when someone calls you out on a mistake (as Professer Bernstein himself is wont to do), pretending like you never made it -- and editing out the record of it -- is, in my very humble opinion, lame.

IndyMac was placed in receivership because of a liquidity crisis, not because of insolvency. Since Schumer's letter became public, depositors had withdrawn $1.3 billion at a rate of approximately $100 million per day. The Federal Reserve and the Federal Home Loan Bank System cut off IndyMac's borrowing window.

Now the real question is this. If Schumer shorted IndyMac before he brought it down, was he selling on inside information? What if he told his aides the day before he brought up the subject and THEY sold IndyMac short?

Sure, it will ruin their credit record, but how much is a good credit record worth?

Interestingly, the significance of a "bad" credit record varies inversely as to the person with the bad credit and his bank.

If only one person has a bad record, it would be devastating to be that one person. On the other hand, if EVERYONE is defaulting, driving a bank toward collapse, a bad credit record doesn't mean much at all. Who else can a bank lend money to if everyone has a bad credit record?

The more important bad credit records collectively become to a bank, the less important they individually are to any single credit holder. The more you are desperate for folks to pay their debts, the less likely they are to do so.

clients (2 this week) who say they are ready to walk away from 6 or 7 houses that are $50k underwater because they don't have tenants and their savings is gone from making the payments.

I have sympathy for those who foolishly thought they could afford the loan for the house they bought to live in, just because the mortgage broker, et al. told them they could. I have no sympathy for those who thought they could make money buying houses to rent out. If people could afford rents that would cover mortgages, taxes, and insurance, they would be buying houses, not renting them.

For anyone wanting to buy a house: Plan on spending at least five years in it. This will bridge any normal dip* in the real estate market since WW II. And get a fixed rate mortgage, so you never get surprised by the amount of the monthly payment.

*Don't buy in towns with declining industries, or one-company towns, unless you can afford to pay cash.